Retirement plans for independent contractors are plentiful.
As an independent contractor, it is you and only you who are responsible for your retirement planning. And there’s no wrong choice. Take a look. I’m sure there’s something to best suit your needs.
As the ultimate boss of your life, you must take tangible steps to ensure retirement is something to look forward to, not freak out over. Let’s go through the plans I’ve recommended to many clients in the past.
I. The Usual Charlie: Traditional Retirement Saving Plans:
A. Individual Retirement Account (IRA) The backbone of retirement plans for independent contractors:
- Traditional IRA: This is the one you usually think about when you hear “IRA”. In general (everything IRS has exceptions, so I’ll just discuss the plans in general) you can contribute money ($6,500 in 2023, $7,500 if you’re over 50) and deduct the contribution on your taxes. You don’t pay taxes on the growth until you take distributions after you retire. The entire distribution is taxed if you took the contribution as a deduction on your taxes.
- Roth IRA: This one allows the same annual contribution (and amount) but it’s not deductible on your taxes. But…you don’t pay tax on any distributions you take after you retire. I advise younger people to start with this one. I started my son’s when he was 11. He’s 27 now. Time is your friend with ROTH’s. You aren’t taxed on any of the growth. The longer you leave it alone, the more growth..
B. Simplified Employee Pension (SEP) IRA: The big brother to the above IRA’s. This one is great when you outgrow regular IRA’s and their contribution limits. A SEP will allow you to contribute as much as $66,000 in 2023. $66k for 30 years is almost $4.7 million, at 5% annual growth. The kicker is to contribute the max you’d need net self employment income of $330,000. You can contribute 20% of your net self employment income.
C. Savings Incentive Match Plan for Employees (SIMPLE) IRA: A little brother retirement plan to a 401(k). I included this one since having an S or C Corp requires you to pay yourself through payroll. If you choose this way to save, you have to offer it to your employees (max 100). You can contribute $15,500 in 2023 with an additional $3,500 if you’re over 50. The business must make a matching contribution (which is also deductible) on behalf of each participating employee. And it’s something good to offer the employees.
II. Solo 401(k) Plan:
A. This one is my favorite for spousal teams. It allows each one to conceivably contribute $66,000 to their retirement, reducing their taxable income by that same $66,000. This one is a mix of a traditional 401(k) plan with a SEP IRA (discussed earlier). To contribute the max, you need to make $210,000 in wages. Much less than the regular SEP.
B. This one is for a true sole proprietor with no employees other than themselves and their spouse. Other than that, you’re out of luck.
C. They’re as easy to set up as any other IRA. Not all brokerage houses do these, but the big ones will. This will give you a wide variety of investments with a cost a lot less than a typical 401(k) plan, with none of the reporting requirements (that you need to worry about).
III. Saving for Medical Issues:
A. Health Savings Account (HSA): While not a retirement plan, an HSA is great way to bank money for future medical needs, while writing off your contributions and paying no tax when you use it. More free money. While this isn’t a retirement plan for independent contractors per se, it can be a big part of your retirement savings.
1. To be eligible to start an HSA, you must have a high deductible health plan (HDHP. Your health insurance plan) with a minimum deductible of $1,500 for a single filer or $3,000 for a family. The plan must also have a max out of pocket of $7,500 for a single filer and $15,000 for a family.
2. Your maximum contribution for 2023 is $3,850 for single filers and $7,750 for family plans.
3. I think of these like medical miracle plans. I think EVERYONE should start one.
Do this:
Contribute the max if possible. If young, pick a plan which allows you to pick what the money is invested in. Don’t do one of those money market plans.
You’ll get a debit card to use on qualified medical expenses.
Hopefully you won’t need to use the card often. What you’re doing is building a nest egg for later when you might really need it.
You deduct the contributions on your taxes – TAX SAVINGS!
Your investment grows without paying tax on dividends or capital gain transactions (remember, no money market plans) – MORE TAX SAVINGS!
You know that cliche about the only two “for sures” in life? Death and taxes? You’re gonna die, but you won’t pay taxes on these plans. ONLY SAVE
IV. Be consistent. Make your Retirement Plan Set and forget.
A. Saving is a skill. You have to learn it. I can’t stress this enough. You don’t want to creep up on 60 and suddenly realize that you’ll be working until you’re 75 (life expectancy in the USA is down to 76.4 years). I’m pretty chill about most things. But this is an important skill to develop. You’re going to need a retirement plan.
B. Set and forget will be hard the first year or so. When I decided to buy my own home, i started saving $700/mo (that was a lot for me then and it was in the 1980’s). It killed me for about 6 months. I still remember when I realized I hadn’t thought of the transfer to savings for a few months. It was freeing..
C. The goal is to save. Sometimes, life throws a hurricane at us and money is an issue. Adjust. If you were putting away $1,000 or $100, adjust it to $500 or $50. Or whatever you can. But don’t stop. Maintain and be consistent.
V. Do your research:
A. From a tax perspective. Limits and requirements change most years. Rules are always being discussed for change in Congress as well. Watch for changes in age requirements in the future.
B. From an investor perspective. You can either find an advisor (they cost) or self direct (you manage). I think the smartest way to invest is via both open and closed end mutual funds. Index funds (think Vanguard) have the lowest management fees and generally do just as good, or better than managed accounts over the long term.
C. Start by doing a risk analysis on yourself. This tells you how risk averse you are and guides you with your investment selections. There are tons of great tools online to help you along.
Conclusion:
The number of retirement plans for independent contractors available makes it easy to create a retirement savings plan, even if it’s just to put away $100 a month. This might be the most important skill you develop. Especially if you are smart or fortunate enough to start young.
Do this:
Open an account somewhere. TD Ameritrade, ETrade, Schwab, …it doesn’t matter at this point.
Set an auto investment of $10, $50, $100. Something. Anything. Do it now. Set it for a monthly contribution.
Forget about it for about 30 years.
With a modest return of 5%, you’ll end up with almost $84,000 with a $100 monthly investment. You contribute $36,000 and it turns into $84,000
That’s the power of compounding. Put money away every month (your financial advisor might refer to this as Dollar Cost Averaging) and watch it grow.
Using one of the above tax deferred plans will let you grow without having to liquidate to pay taxes every year.
If you’re at least twenty years from retirement, start a ROTH IRA and contribute the max if you can. Every year. Contribute $7,000 a year for the above thirty years and you’ll have almost $500,000! And pay no tax on distributions! That’s as close to free money as Uncle Sam (the bastard) will allow!
Or contribute $66,000 to a SEP for the next 30 years and walk away with $4.7 million!
Think big people.